Joe Alala - President and CEO Steve Arnall - CFO Jack McGlinn - COO.

Mickey Schleien - Ladenburg John Hecht - Jefferies Vernon Plack - BB&T Capital Markets Terry Ma - Barclays Christopher Nolan - FBR and Company.

At this time, I would like to welcome everyone to Capitala Finance Corp's Conference Call for the quarter ended March 31, 2016. All participants are in a listen-only mode. Question-and-answer session will follow the company’s formal remarks.

Today's call is being recorded and a replay will be available approximately three hours after the conclusion of today's call on the company's Web site at www.capitalagroup.com under Investor Relations' section.

Hosts for today's call are Capitala Finance Corp's Chairman and Chief Executive Officer, Joe Alala; Chief Operating Officer, Treasurer and Secretary, Jack McGlinn; and Chief Financial Officer, Steve Arnall. Capitala Finance Corp issued a press release on May 9, 2016 with details of the Company's quarterly financial and operating results.

A copy of the press release is available on the Company's website. Please note this call contains forward-looking statements that provide information other than historical information, including statements regarding the Company's goals, beliefs, strategies, future operating results and cash flows.

Although the Company believes these statements are reasonable, actual results could differ materially from those projected in the forward-looking statements.

These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under the section titled Risk Factors and forward-looking statements in the Company's quarterly report on form 10-Q. Capitala undertakes no obligation to update or revise any forward-looking statements.

At this time, I would now like to turn the call over to Joe Alala..

[indiscernible] We directly originated 27.5 million of new investments with a debt yielding 13.5%. The yield on the total portfolio at March 31 is 12.4%. This is the fourth consecutive quarter we have seen yields on aggregate portfolio increase. It's up 50 basis points during that time to 12.4% through March 31st.

Moreover, the average yield on debt deployments over the past three quarters has been 12.7%. While our yields have been increasing we would like to point out that the total leverage ratio at the portfolio level have remained constant.

This demonstrates we believe that we are not chasing yield but whether we are sourcing unique investment opportunities through our robust direct origination strategy. Management continues to waive incentive fees to support net investment income and distribution coverage.

However, management expects to monetize several equity investments this year, generating significant gains in providing liquidity to reinvest into debt securities to help reduce the impact of non-performing investments and ultimately reducing the reliance on the fee waiver. Net asset value per share of 16.29 is down from 17.04 at year end.

This decline was driven by energy-related depreciation. Jack and Steve will provide additional details on this. Energy investments based on fair value are now around 6% of the portfolio compared to 12% at the end of 2014. It's important to note that non-energy investments appreciated by approximately 5 million during the quarter.

Looking ahead, we continue to focus on distribution coverage with net investment income. We continue to actively portfolio-manage under-performing investments and we are seeing nice progress there. And we continue to originate proprietary deal flow and focus on generating high risk-adjusted return for our shareholders.

At this point, I would like to turn the meeting over to Steve and Jack to provide additional comments on our operating and financial performance..

Thanks, Joe, good morning. As previously mentioned, on May 9th we filed the press release with our first quarter 2016 earnings. In addition, we also posted a first quarter 2016 investor update to our website, providing additional details about the Company, the investment portfolio and other financial related trends.

Also, please consider visiting the investor relations section of our website to automatically receive email notifications of Company financial information, press releases, stock alerts or other corporate filings. During the first quarter of 2016 total investment income was 17.4 million, an increase of 3.4 million over the same period in 2015.

Total interest fee and pick income was 2.5 million higher in the first quarter of 2016 compared to '15, driven by a larger investment portfolio. All other income increased by 0.9 million. Total expenses for the first quarter of 2016, net of the incentive fee waiver, were $10 million compared to 9.2 million in 2015.

The increase is primarily attributable to, one, an increase in interest and financing expenses of 0.4 million related to advances under our senior secured line of credit; and two, an increase of 0.3 million in management fees.

Net investment income totaled 7.4 million or $0.47 per share for the first quarter of 2016, compared to $4.8 million or $0.37 per share for the same period last year. As previously mentioned by Joe, net investment income and the coverage of distributions remain our highest priority.

Net realized losses totaled $2.3 million or $0.14 per share for the first quarter 2016, compared to net gains of $9.3 million for the same period last year. Net unrealized depreciation for the first quarter of 2016 was $9.3 million compared to depreciation of $4.3 million the previous year. Jack will provide additional details in just a moment.

The net decrease in net assets resulting from operations during the first quarter of 2016 totaled $4.2 million or $0.27 per share, compared to a net increase of $9.9 million or $0.76 per share last year. Total net assets of $257.4 million at March 31, 2016 equate to $16.29 per share compared to $17.04 per share at the end of the year.

From a liquidity standpoint we had cash and cash equivalents of $14.3 million at March 31, 2016 compared to $34.1 million at December 31, 2015. SBA debentures outstanding at March 31, 2016 totaled $182.2 million with an annual weighted-average interest rate of 3.43%.

In addition, the Company has $113.4 million of notes outstanding at fixed interest rate of 7.125%. Lastly, the Company has $73.0 million drawn and $47 million available under its senior secured revolving credit facility at a regulatory leverage ratio of 0.72 X at the end of the quarter.

At the end of the quarter the Company's balance sheet and future net investment income will not be materially impacted by changes to short term interest rates. Please see form 10-Q for detailed information about the Company's interest rate sensitivity. At this point, I would like to turn the call over to Jack..

Thanks, Steve. During the first quarter we had gross deployments of $27.5 million with a 13.5% yield on debt securities. Net deployments amounted to $17.3 million and our total weighted-average yield on our debt portfolio increased to 12.4% from 12.3% last quarter.

Realized losses of $2.3 million were recognized during the quarter, mostly related to a $2.5 million loss recognized on the exit from Source Recycling, formerly a nonaccrual asset. Net unrealized depreciation was $9.3 million.

Oil and gas related investments depreciated by approximately $14 million while the remainder of the portfolio appreciated by $4.7 million. As of the end of the first quarter, the Capital portfolio consists of 56 companies with a fair market value of $599.7 million on a cost basis of $586.8 million.

Senior debt investments represent 36.2% of the portfolio; senior subordinated debt, 44.4%; senior liquid loan fund, 3.1%; and equity warrant value of 16.3%. In regards to portfolio quality, we continue to maintain a sub 2 internal weighted average risk rating of 1.84, while average leverage of the portfolio remains stable at 3.8 X.

At the end of the quarter there were four investments on nonaccrual with a fair value and cost basis of $12.7 million and $42.4 million, respectively, an improvement from the prior quarter. As a further update on our investments in the energy space, the five investments at fair value totaled $37.9 million or 6.3% of the portfolio.

As previously mentioned, energy-related investments depreciated $14 million during the quarter. In total, the fair value of our energy investments is 51% of the cost basis while the three oil specific investments are marked at 27% of cost.

In regards to market conditions, we continue to see strong proprietary deal flow despite the overall reduction in M&A activity in the market. In line with our liquidity position, our underwriting has become more selective as we identify the best risk adjusted returns. And with that, I will turn it back to Joe..

Thanks, Jack. Just to summarize, we continue to focus on distribution coverage with NII. You see we're marking down appropriately through third party independent evaluations. Our energy investments are now down to 6% on the fair value basis of the portfolio.

And we are continuing to focus on directly originated lower middle market transactions where we can obtain the highest risk-adjusted returns for our shareholders. With that, operator, we are ready to address questions..

[Operator Instructions] And your first question comes from Mickey Schleien from Ladenburg. Your line is open..

Joe, can you walk us through the decision to sell or exit Source Recycling? Did you get a bid and sell the position? Or was the company recapitalizing and you chose not to participate?.

Hey, Mickey, this is Jack, I will answer that one. That was one, again, it's been non-accrual for a while. We were working closely with all the parties there. We had an opportunity as the company was restructuring to either roll over, stay in that, or exit at a number that was a little bit off hour mark, so we decided at that point to exit.

Take the proceeds, be able to reinvest to those, and to put that in the exit column. We were spending a lot of time on it and there was little stability in the commodity pricing for that business. So we just thought it was the best decision at that point to exit..

I understand, Jack. A couple of other portfolio questions.

I'd like to understand if the valuations of Flavors Holdings and Immersive Media reflect credit problems? Or those technical factors perhaps due to a bid out there?.

I think Flavors was adjusted to a bid that was in the market and so we adjusted to that. And then IMSC, I think I mentioned this several quarters ago, they also went through a transaction and our investment actually rolled over in that transaction. It's now a reset on the time frame of that, so it will be a longer term hold.

And the evaluation reflects the time value of money of when we think we will be able to recover that investment..

Okay, Jack, one more portfolio question. Sierra Hamilton is on accrual. I don't have it in front of me, but I think the mark was around 50%.

Is that a second lien? Can you give us an update on that company?.

Sierra Hamilton, there is a second lien. I'm sorry, it's a senior, but there is an undrawn revolver in that deal that's in front of us. There was a mark that we adjusted, our valuation to, on that one. So again, that does reflect some bids that were going on in the market there.

It does continue to perform and we think that's one that will continue to do well, but they are still up against the industry pressures..

I understand. Just one housekeeping question, maybe for Steve.

Is the cash on the balance sheet mostly in the SBIC and destined to pay the debentures due later this year?.

It's a blend. It's in the two SBIC subs and the parent. The debenture you are referring to is September 1st. We have got some cash set aside for that and we also expect to realize some global and unscheduled repayments throughout the next five months that will take us to that repayment..

Thank you, our next question comes from John Hecht with Jefferies. Your line is open..

First question on the composition of the P&L, we have seen a pickup in the dividend in chem over the past few quarters. I'm wondering if you can take us through that.

Was that related to some restructurings and so forth? And what is a good run rate expectation as we think about this year with respect to dividend in chem?.

This is Steve. We had 1.3 million in dividends this period, which ended up being about 7% of total investment income, a little higher than normal. From a recurring standpoint, the one item that will be in there quarterly will be the dividend from the senior loan fund, and that is probably 0.5 million or more, maybe 500,000 to 600,000 quarterly.

Beyond that, with these equity positions we see from time to time, some dividend income. We had a couple of those this quarter. In terms of modeling, I'm not sure that I would count on those every quarter. So from a modeling standpoint I think $500,000, $600,000 is certainly going to be in there every quarter. Beyond that, it's going to be choppy..

Second of all, you talked about the cash in the SBA. You do have some capacity for liquidity from repayments as well as some capacity in the borrowing line.

How do you guys think about -- how should we think about how do you think about goals or expectations for portfolio growth this year? Is this a year where we'll just want to replace runoff and more focus more on credit? Or do you still see good opportunity to grow the balance sheet from here out?.

I would generally agree with what you said. In the foreseeable future, we will be taking repayments and recycling money and hoping to do 20 million net investments per quarter. But, in terms of other avenues of liquidity, certainly I think Joe's mentioned in the past, some work being done on the private credit side and some other initiatives.

But yes, I think you are correct..

And the final question is, you've used your equity, I think equity composition to about 16% of the portfolio now.

Is that the kind of rate or the portion of the portfolio you'd want to keep it at? Should we think about that moving up or down? Do you have any intentions there?.

Yes, actually at that level we are comfortable, I think. Especially if you look at the presentation that we have on our website, it breaks that out in a little bit more detail. You'll see a good portion of that is in three or four of our investments that have had very strong appreciation.

So as those move through an exit process, as they may do, then that number could come down. Again, as we underwrite new investments, we are not underwriting, we are not investing heavily, in equity. So that number could come down subject to further appreciation which we obviously welcome..

Thank you. Our next question comes from Vernon Plack with BB&T Capital Markets. Your line is open..

I know you mentioned that you're going to be harvesting some gains, hopefully this year. There's one big write up in the portfolio, I believe, on the equity side. Medical Depot, I think that was written up by more than $3 million.

Could you give me a little color on that, Jack?.

That is a company that could potentially exit this year. I think the company serially has gone through acquisitions and has continued to increase both their revenue and profitability.

So, some of it is an increase in the mark to recognize their growth and some of it is more to recognize what we are hearing from the market of what potential evaluations would be..

Okay. And just one more in terms of an update on where you are with the private credit fund..

Vernon, this is Joe. We are actively out listening to investor interests and we are still on a timeline that we think will add significant capital in that strategy this year.

But as you know, and as you are probably hearing from other groups that are out raising private funds, predicting a timeline on a private credit fund is hard to do because you are moving at other's pace. We are making really good progress and we are seeing some factors that lead us to believe it's sooner rather than later..

Thank you. And our next question comes from Terry Ma with Barclays. Your line is open..

Hey, guys. Wanted to touch with the equity for a second. You guys mentioned in your prepared remarks, you expect to add some equity positions later this year.

Can you give us a sense of how much in fair value that is? Do you have an idea how much you can potentially redeploy into the investments?.

Terry, this is Steve. I wish we could be more specific with you in terms of timing and amounts. That's not something we're comfortable talking about publicly right now. If you look at the page on our NVR deck on page 10, there is a list of all our equity positions. Beyond that it would be inappropriate to really get into much time in there.

Okay.

But would it be fair to assume that the most appreciated investments will be candidates?.

Sure, we would like to think so..

Terry, this is Jack. I think some of our hesitancy is we have seen both inside our portfolio and outside of it. There is a lot of busted processes that go on. Maybe a company doesn't get the value that they're looking for and they pull it off the market. Or there is a lot of re trading going on in the market.

Even if a company goes into a process to exit, it is not a guarantee that they're actually going to get there. So we're very hesitant in throwing out numbers of what we think is going to happen, because at the end of the day we don't control it..

Okay, that's fair. And then on the weighted average yield, you guys have mentioned it's increased I think like three or four consecutive quarters.

Can you talk about what is driving that, whether it is redeploying into higher yielding assets, wider spreads? Or is there something different you guys are doing?.

This is Joe, Terry. I think it really comes down to how we are finding these unique deals. The pricing is better now than it was over the past prior quarters because the liquidity in the market has contracted, so we are able to find higher yielding deals.

We are not having to go do higher leverage deals to find those yields, so we are not chasing yield. It's just that pricing has increased throughout the industry as liquidity has contracted.

We do have this robust pipeline of deals through our six offices that we can find and we are cherry picking with our liquidity now, the most high risk adjusted deals. This past quarter 13.5%, I think it's been a while since we've seen those type yields and credits of the size we're finding. We think that will continue for the foreseeable future.

And that is why we are really focused on redeploying any repayments of the portfolio and adding liquidity to the strategy with some private credit funds..

Thank you and our next question comes from Christopher Nolan with FBR and Company. Your line is open..

Joe, in your prepared remarks you mentioned up front reinvestment to leverage.

Were you referring to reinvesting into portfolio companies or paying down CPTA debt?.

More of the reinvesting into new investments with higher yield. We are finding some great investment opportunities. So if we monetize, for example a 10 million equity position, we can take that 10 million, put it into -- the last quarter -- a 13.5% yield. And that really is accretive right to the bottom line.

So that is really how we are going to address the non-performing assets from a yield perspective and get back to where we are covering the distribution with NII without having to do incentive fee waivers..

For the maturing debenture in September, will that be replaced or how does that go? You have another application for another SBA license out there.

How should we look at SBA debt going forward?.

Initially we get to 9/1, it will be repaid. Beyond that, there's a broader strategy that we talked to you guys about back in April. Joe, I don't know if you want to touch on how that process stands or not..

Eventually, we have been long participants as a firm in the SBIC program, it is a great program. It really has access to some low-cost fixed debt. We are in constant dialogue with SBA and a lot has to do with their timeline. We would go back into that program in the BDC and try to draw down additional leverages through that program.

So we have had nice progress there on our private funds having access. So we believe we will have that in the BDC. We are in constant dialogue with SBA and really on their timeline we will go back and pursue another license to obtain that low cost SBA leverage..

But when this 11.5 million goes away on September 1st, we should not, at least in the near term, expect it to be replaced with another debenture from the SBA, correct?.

Correct..

Thank you. [Operator Instructions] I'm showing no further questions. I would like to turn the call back over to Joe Alala for any closing remarks..

Thanks, everyone, for your time. We will be around all day if you want to call us directly and have any further questions. And we appreciate it. Thank you..

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day..